Thoughts on Diversification

[ericd1]

Parsad,

 

You are right on about safety of capital & diversification. Last year's fat tail (black swan?) market disproved many ivory tower theories about the value of diversification. Unfortunately alot of fixed-mix index fund gurus (and others) discovered sometimes there's no place to hide. A 37-year study of seven asset classes ('70 thru '06) shows terrific results, but look at 2008 and you get a different reality.

 

7 Asset classes: US large, US small, Non-US, intermediate US bond, cash, REIT & Commodity

 

7 class 37-year average annual return 11.5%  with Std Dev < 50% of equities alone. Only four years with losses - worst loss 5.3%

 

7 class - 2008 - loss 26.9% (ouch!)

 

 

 

 

[kyleholmes]

You are correct in my opinion Sanjeev when you say that diversification is dependent on the investor's abilities and emotional constitution, thus that it isn't a one shoe fits all type of question.

 

However, I have some thoughts on some of the other points. Figured I would play devils advocate here, and maybe I will proven to be wrong and end up switching my thinking! Good discussions never hurt! Also is many ways to invest ....some like concentration, net/net's/ jockey picks, etc. so both sides can be right... just look at the difference between let's say Whitman and Berkowitz... and both are still good.

 

1) Throughout some of Fairfax's history, Prem's 5-10% outside would have been some money, but not a significant amount. So, should he have moved money out of Fairfax into something else to 'diversify'? If he could have found 10, or 100 other places that were just as good, I would argue absolutely... but I am sure that he tried and could not. Ditto for Warren in the early stages of Berkshire.

 

Staying concentrated is what has created most of the richest in the world.... so see no reason not to be, without being stupidly concentrated. Some on the board have said that if it was your own business they would be comfortable putting 100% in.. do they not trust Prem (Chief Risk Officer) is thinking long and hard for them out of his own self interest? (Prem is probably better to make the decisions too!) To avoid gambler's ruin I argue against 100% but don't argue against a concentrated portfolio. Prem and Warren aren't concentrated for charity, but because they think that it's the best allocation of there own money... which doesn't just mean the highest return available, because we know Buffett makes higher returns in his personal portfolio. Got to get paid for when you are right! Example-100 stocks and one doubles, you now have $101!

 

2) People wonder why in hockey or any other sport for that matter, a team gets a lead and ends up blowing it? This is common and is largely because they quit doing what got them the lead in the first place! Yes, there are certain things that you change(ie- Play the trap, etc.) but the best sports teams I have ever seen seem to just keep playing the way that got them the lead in the first place.

 

A friend of mine over the last couple years has been asking if he should change the way he has played the 'game' over the years, as he has more than enough money to live for many generations.... and he has concluded that by trying to avoid losing, you end up losing... just like in sports so he has decided to keep doing what he is doing!! What has got him to where he is (investing for the long term, concentrated holdings, focusing on downside) will protect his wealth and make it grow, and he has decided that he will continue to invest this way instead of changing and 'blowing it'!

 

What has worked for Prem and Warren is what they should continue to do. Everything else is irrelevant for most people... except when you are quite old and of more limited means. Go with what works!

 

3) Munger says to be a good value investor you need a f-you attitude to a degree. I understand that you need to temper the market volatility for some of your shareholders, but maybe that is telling a person that they have the wrong shareholder's?  If I remember correctly it is Munger who gets very upset when he is asked the question about how you would act different if it was just your own money you were investing versus running a public company or a partnership of sorts.

 

Sanjeev, you would have a lot of knowledge with this, more than I would, and would have had to deal with a lot of difficult circumstances due to other's temperaments in the last while, so I am in no position to argue this point but know that any coach I have ever seen in hockey that coaches to keep other's happy, ends up sinking the ship... and he feels terrible about it, because he wasn't even doing what he actually wanted to do!

 

 

Please let me know what board-members think about these points!

 

Kyle

 

* Small businesses that get the 1000% a year, usually are forgetting about the implicit cost of not working else were(opportunity cost) that would definately lower your 'actual' returns on your investment. If they are already factoring that in, those are quite the returns!

[Munger_Disciple]

Kyle,

 

I agree with your comments. As Buffett pointed out, one should decide if he is a no-nothing investor, or if he is a capable investor. If he belongs to the first category, he should buy a low-cost index fund with a dollar-cost averaging method. If he is a capable fellow, then he should concentrate his investments in a few good companies with zero risk of permanent loss of capital. If the investor's assessment of himself is wrong, hopefully he recognizes his shortcomings in time and sticks to indexing going forward.

 

Sreenr

[bargainman]

I agree with your comments. As Buffett pointed out, one should decide if he is a no-nothing investor, or if he is a capable investor. If he belongs to the first category, he should buy a low-cost index fund with a dollar-cost averaging method. If he is a capable fellow, then he should concentrate his investments in a few good companies with zero risk of permanent loss of capital. If the investor's assessment of himself is wrong, hopefully he recognizes his shortcomings in time and sticks to indexing going forward.

 

Personally i don't buy an all or nothing approach.  There is a range.  Also as I pointed out in my post above there are many value investors who have averaged very high returns using a highly diversified approach.  Including Ben Graham the father of value investing!  I mean is anyone going to argue that Ben Graham was not "A capable investor"?  Being that he wrote Security Analysis, the Intelligent Investor, was the teacher of Buffet, among many others, that he used a highly diversified strategy in his partnership, that he was incredibly knowledgeable when it came to investing and analyzing companies, I don't buy that 'if one is a capable investor, one should be concentrated".  Ben Graham was most certainly a more than capable investor, confident in his skills, and he chose for many many years to be highly diversified.

 

I think highly skilled individuals can choose to be diversified.  Seth Klarman is often quoted as saying "You never know everything".  (and sorry Ben Hacker, I am just learning more about him.. I knew he had been holding 40% cash, but something made me think he was a focused investor.. just read that apparently if he's going to take a 10% position, he wants a board seat...) That is so true.  I mean I work at a 6000 person company every day, studying it inside and out all day long, and I know next to nothing about it!  If someone isn't a full time investor they have no hope of truly understanding everything about a company.  Even if they are a full time investor they probably don't know a whole lot.  I mean Buffet bought GenRe and almost got killed!  Buffet!  When Buffet bought Geico he told someone "This is the first time I've bought an investment that may go to zero".

 

I think that Buffet was really the first or at least the major proponent of concentrated investment.  But remember, Buffet knew Security Analysis inside and out. Apparently he used to recite passages of it back to Dodd and Graham.  He read it many many times and had what sounded like an almost photographic memory.  He's brilliant and probably there are few who will ever be at his level.  So the question is, if he was the guy who started the 'focused investing" trend, are you really in the same category?  I'm certainly not.  That said I know a lot about investing and am not in the know nothing crowd either.  So I'm somewhere between.  Because I don't choose to concentrate 40% of my worth in a single investment doesn't make me a "not capable" investor, just like it didn't make Walter S., Ben Graham, Royce, or any of the others who were highly diversified 'not capable'.  Even in other styles there are successful highly diversified capable investors (Peter Lynch and Shelby Davis come to mind)

 

As Sanjeev said, nothing can be viewed in a vacuum.  But my main point is that other than confidence in one's abilities, and capability as an investor, there are other factors that can decide if someone should be highly diversified or not.  Also, highly capable investors can and do choose to be focused OR choose to be diversified!  I just have to hammer on this point cause it keeps coming up over and over, and the implication is always "if you're very diversified, you're not capable".  But that's so untrue.

 

Just my 2c added to my 2c in my previous post for a total of 3.5c (since I probably repeated some of my previous post :-) )

 

[bargainman]

OK one more thing then I'll stop  :-)  I do agree that if you're not capable you should definitely NOT be concentrated in your investments!  So if you break it into a chart with the 2 dimensions being "capable/not capable", and "diversified/not diversified"  I'd make it be this:

 

	Diversify	Focused
Capable	OK	OK
less capable	OK	NOT OK

 

I think I'm up to about 5 or 6cents by now  :o

[Parsad]

Staying concentrated is what has created most of the richest in the world.... so see no reason not to be, without being stupidly concentrated. Some on the board have said that if it was your own business they would be comfortable putting 100% in.. do they not trust Prem (Chief Risk Officer) is thinking long and hard for them out of his own self interest? (Prem is probably better to make the decisions too!) To avoid gambler's ruin I argue against 100% but don't argue against a concentrated portfolio. Prem and Warren aren't concentrated for charity, but because they think that it's the best allocation of there own money... which doesn't just mean the highest return available, because we know Buffett makes higher returns in his personal portfolio. Got to get paid for when you are right! Example-100 stocks and one doubles, you now have $101!

 

We run a pretty concentrated fund...anywhere from 5-12 ideas.  At the moment, we have about 65% of the capital in five ideas.  So, I agree that a fund should be relatively concentrated.  

 

In regards to the putting all your capital into one stock:  Why didn't Prem put all his money into Berkshire?  Prem puts nearly all of his wealth in Fairfax, because Prem is more comfortable with Prem's decisions.  Buffett puts nearly all of his wealth in Berkshire, because Buffett is more comfortable with Buffett.  Sanjeev puts nearly all of his wealth into Corner Market Capital and the MPIC Funds, because Sanjeev is more comfortable with Sanjeev, than he is with Prem or Buffett.  That's just the way it is...you can go ask Sardar the same thing, and he'll tell you the same.  That doesn't mean any of us aren't willing to make a bet on each other at given times, but that it is unlikely that we would hold onto that bet for the duration of the game.  I've had my entire net worth in Berkshire and Fairfax at various times...but I just wouldn't leave it there forever...primarily due to size.  Even Fairfax's growth will slow over the next decade.

 

 

A friend of mine over the last couple years has been asking if he should change the way he has played the 'game' over the years, as he has more than enough money to live for many generations.... and he has concluded that by trying to avoid losing, you end up losing... just like in sports so he has decided to keep doing what he is doing!! What has got him to where he is (investing for the long term, concentrated holdings, focusing on downside) will protect his wealth and make it grow, and he has decided that he will continue to invest this way instead of changing and 'blowing it'!

 

What has worked for Prem and Warren is what they should continue to do. Everything else is irrelevant for most people... except when you are quite old and of more limited means. Go with what works!

 

Both Boston and San Jose pretty much played the same game in the playoffs that they played in the regular season, yet they did not dominate the playoffs.  I humbly beg to differ that they actually didn't adapt their game to the playoffs, and kept doing the same things that got them into trouble.

 

Bill Miller didn't do anything different in 2007 and 2008, that he didn't do in past years.  Neither did Mohnish or a myriad of other investors.  I think that was the problem.  They did exactly what they were taught.  They stuck to the playbook and listened to the coach.  Yet here we have Prem who changed his game...he went and bought something that has nothing to do with Ben Graham investing...credit default swaps.  He bought insurance!

 

I believe it was Sam Mitchell at our dinner, who said something to the effect that Buffett went and did something completely different than what he was saying for the millionth time, and everyone started chuckling.  Buffett preaches what he has to, so that he has a group of shareholders that buy into the cult.  It helps him long-term, and the end result is that it ends up helping those shareholders.  Yet, Buffett often does things that are contradictions to what he preaches.

 

3) Munger says to be a good value investor you need a f-you attitude to a degree. I understand that you need to temper the market volatility for some of your shareholders, but maybe that is telling a person that they have the wrong shareholder's?  If I remember correctly it is Munger who gets very upset when he is asked the question about how you would act different if it was just your own money you were investing versus running a public company or a partnership of sorts.

 

I think you need a f-you attitude in relation to the investment process..what you are buying and what you are selling.  I don't agree with that sentiment when it comes to empathizing with your partners.  It's their capital and they are your partners.  Buffett wrote to his partners as if they were all his aunt...in a simple to understand, straight forward manner.  He laid out the ground rules of how the funds would operate, but he never showed any sort of take-it-or-leave-it mentality.  I guess it comes down to personal choice.  I can say for a fact that it never hurt his results, and it certainly hasn't hurt ours in any manner.  

 

You could probably get away with that more in a public corporation than you can in a partnership.  We want our partners to be able to redeem their capital whenever they want...we don't lock it up, and we won't ever close the fund down so that they can't redeem.  

 

Sanjeev, you would have a lot of knowledge with this, more than I would, and would have had to deal with a lot of difficult circumstances due to other's temperaments in the last while, so I am in no position to argue this point but know that any coach I have ever seen in hockey that coaches to keep other's happy, ends up sinking the ship... and he feels terrible about it, because he wasn't even doing what he actually wanted to do!

 

Bobby Knight has won three NCAA championships, but how many of you want to be Bobby Knight?  I certainly don't.

 

I think a coach's entire job is to find a way to motivate his team, and help them form a cohesive bond that allows them to reach their maximum potential, regardless of the circumstances.  I bet there are many different personalities within Fairfax's executive teams...just take a look at Sam Mitchell, Greg Taylor and Dennis Gibbs.  I think anyone who has met the three, would say that for the most part, they have very different personalities, even though they operate very successfully as a team.  

 

Now how do you manage the egos of three very different, very successful people, with three significantly different areas of expertise?  Well, a good coach takes more of the blame and less of the credit first of all.  Prem does that all the time.  In the years I've known him, I've never ever heard Prem take any credit for himself...ever!  It's always someone, or "we at Fairfax", or something to that effect.  Second, he knows how to make everyone feel useful...give them a very specific purpose and goal.  Why are the best penalty-killers in the league, guys that don't do a whole heck of alot other than that?  Third, you get everyone to buy in to the philosophy.

 

We mitigate risk to a certain degree for two reasons:  preservation of capital, and because regardless of how good the culture is at a company, you will always find investors that cannot handle the volatility as well.  It doesn't mean they aren't good long-term partners, but I think a 50% drop would scare off at least 30-40% of partners in a fund.  So unless you can meet redemptions for all those people, or lock up your fund, you are going to have to shut down.  

 

Take a look at Legg Mason.  You had a manager who was a God, and beat the markets for 16 years in a row.  One hit and he loses more than half his assets.  Miller runs a mutual fund, so he wouldn't have to close but what about all those hedge fund managers out there who did.  Even in Mohnish's case, he's fortunate that his redemptions are just once a year, and the bulk of the losses came in the last two quarters.  He didn't get much in redemptions.  But if his investors were allowed to redeem into the 1st Q of this year, it would have been a much different story.  His fund will recover alot of ground over the extra year he has now, and he'll end up keeping most of his partners, but if redemptions were allowed into the 1st quarter, he may have had a difficult time meeting redemptions.  In Seller's case, he closed his fund!  Cheers!      

 

 

 

 

 

 

[oec2000]

This is how I would approach the diversification decision:

 

1) I would make a distinction between business ownership and portfolio investing.

 

Firstly, most business owners do not have the option of diversification when they start out. Secondly, if the business is successful, they are able to compound the growth of their business at very high rates. Thirdly, if the business does not do that well, they do not have much resources to diversify outside the business. Under any of these circumstances, the business owner likely ends up with a very high proportion of his net worth in his business.

 

It is only in the second situation where the business owner has an option of diversifying away from his business. At this point, the prudent ones may already have built significant wealth outside the business (e.g. Buffett and Watsa) that they can afford to take the risk of the business going under - in which case, they can safely continue to have the concentration in that one business.

 

The portfolio investor has a choice from day one to diversify. If he chooses not to, he must either be very sure of what he is doing or he should be able afford the risk of severe loss.

 

In the case of a business owner, the default option is to be very concentrated; for the portfolio investor, the default option is to be diversified. The business owner also has an important edge - he knows everything about his business; the portfolio investor does not.

 

2) Use the Kelly Formula (2p-1) to set the absolute upper limit of exposure for each investment.

 

3) Decide where I am in the spectrum of objectives, one extreme being to maximise wealth the other extreme being to preserve wealth. A twenty year old with $10,000 will be at one end of the spectrum while a 70 year old retiree with $5m will be at the other end.

 

4) All things being equal, being diversified (within limits) is better than not - diversification is a free lunch. Therefore, if I can find 5 stocks that meet my risk and return criteria, I should buy 5 rather than just 1 or 2 stocks.

 

5) Diversification is not just about managing risk; it can also be about managing returns. If you choose to buy only two stocks in your portfolio, you may not lose everything but if they do not perform as well as you expected, you returns could be lousy. The odds of getting 2 out of 2 wrong is quite high, much higher than 5 out of 5.

 

6) Given that stocks tend to move in tandem, the chances are high if FFH were to sell off to $200 that there would be plenty of other attractive opportunities in which case it would make sense to have more stocks. Of course, it is possible that FFH could sell off for company specific reasons - but if that were the case, you probably would not feel comfortable having such a concentrated position in one stock.

 

In conclusion, I really cannot see myself having either the need or the desire to put 50% in any one stock. Even if I felt compelled to, I would try to use risk management tools (like options) to achieve the same exposure without the same risk.

 

One last point. Buffett's and Watsa's very high concentration of their net worth in BRK and FFH must be viewed in the context that BRK and FFH are themselves very well diversified. It is more instructive to study how BRK's and FFH's portfolios are invested to understand their approach towards concentration/diversification. In FFH's case, the implication is that their max holding in a stock is about $500m, i.e. 2.5% of their $20b portfolio or 10% of their $5b equity portfolio.

[SharperDingaan]

 

We use 2-3 equities, cash, & fixed income. 5 assets.

If we really pushed it maybe 1 equity for 40-45% of total assets, but a very rare event.

 

SD

[Munger_Disciple]

In my opinion, a portfolio with up to 10-12 position is a concentrated portfolio. To the other board members who think they can beat the indices with a broadly diversified portfolio, all I can say is good luck!

 

Just an interesting tidbit about Ben Graham: By his own admission, he made most of his money on one stock! He pointed it out at the end of Intelligent Investor.

[kyleholmes]

Staying concentrated is what has created most of the richest in the world.... so see no reason not to be, without being stupidly concentrated. Some on the board have said that if it was your own business they would be comfortable putting 100% in.. do they not trust Prem (Chief Risk Officer) is thinking long and hard for them out of his own self interest? (Prem is probably better to make the decisions too!) To avoid gambler's ruin I argue against 100% but don't argue against a concentrated portfolio. Prem and Warren aren't concentrated for charity, but because they think that it's the best allocation of there own money... which doesn't just mean the highest return available, because we know Buffett makes higher returns in his personal portfolio. Got to get paid for when you are right! Example-100 stocks and one doubles, you now have $101!

 

We run a pretty concentrated fund...anywhere from 5-12 ideas.  At the moment, we have about 65% of the capital in five ideas.  So, I agree that a fund should be relatively concentrated. 

 

In regards to the putting all your capital into one stock:  Why didn't Prem put all his money into Berkshire?  Prem puts nearly all of his wealth in Fairfax, because Prem is more comfortable with Prem's decisions.  Buffett puts nearly all of his wealth in Berkshire, because Buffett is more comfortable with Buffett.  Sanjeev puts nearly all of his wealth into Corner Market Capital and the MPIC Funds, because Sanjeev is more comfortable with Sanjeev, than he is with Prem or Buffett.  That's just the way it is...you can go ask Sardar the same thing, and he'll tell you the same.  That doesn't mean any of us aren't willing to make a bet on each other at given times, but that it is unlikely that we would hold onto that bet for the duration of the game.  I've had my entire net worth in Berkshire and Fairfax at various times...but I just wouldn't leave it there forever...primarily due to size.  Even Fairfax's growth will slow over the next decade.

 

I agree with everything said here!

 

A friend of mine over the last couple years has been asking if he should change the way he has played the 'game' over the years, as he has more than enough money to live for many generations.... and he has concluded that by trying to avoid losing, you end up losing... just like in sports so he has decided to keep doing what he is doing!! What has got him to where he is (investing for the long term, concentrated holdings, focusing on downside) will protect his wealth and make it grow, and he has decided that he will continue to invest this way instead of changing and 'blowing it'!

 

What has worked for Prem and Warren is what they should continue to do. Everything else is irrelevant for most people... except when you are quite old and of more limited means. Go with what works!

 

Both Boston and San Jose pretty much played the same game in the playoffs that they played in the regular season, yet they did not dominate the playoffs.  I humbly beg to differ that they actually didn't adapt their game to the playoffs, and kept doing the same things that got them into trouble.

 

Bill Miller didn't do anything different in 2007 and 2008, that he didn't do in past years.  Neither did Mohnish or a myriad of other investors.  I think that was the problem.  They did exactly what they were taught.  They stuck to the playbook and listened to the coach.  Yet here we have Prem who changed his game...he went and bought something that has nothing to do with Ben Graham investing...credit default swaps.  He bought insurance!

 

I believe it was Sam Mitchell at our dinner, who said something to the effect that Buffett went and did something completely different than what he was saying for the millionth time, and everyone started chuckling.  Buffett preaches what he has to, so that he has a group of shareholders that buy into the cult.  It helps him long-term, and the end result is that it ends up helping those shareholders.  Yet, Buffett often does things that are contradictions to what he preaches.

 

As for Boston and San Jose… they ran into good teams and just were not the better team. But over a lot of different sports games, not just a couple series’, it is quite common to ‘pucker’ up and change what you have done to get the lead… causing you to end up losing. Munger didn’t believe in 73-74’ that he needed to change his strategy because it hadn’t worked lately, and neither should investors who had trouble lately if there strategy is still valid. A good coach will play the same way when he is down just as he will when he’s up, because over the long term if his strategy is sound, it will work out for him. Think the problem with these investors was that they didn’t use Peter Lindmark’s 10-20% of the time macro matters idea… and I can say that I never either.. felt things were in excess but macro never mattered, and built a dingy instead of an ark!

 

Prem I would argue has not really changed his game as he has done things like this in the past, not using CDS but the same type of idea (it rhymed) when he bought in late 80’s puts on the Nikkei, and in the late 90’s puts on the internet bubble.  Value can be found many different ways and this is one way that Prem has found it in the past… very Templeton like!

You are right that Buffett does things that contradict what he preaches, but it really doesn’t contradict his style of investing at all… Derivatives are weapons of mass destruction as he said, but that doesn’t mean that they can’t be used if a mis-priced bet is found, but this leads everyone to think that he is contradicting himself.

 

3) Munger says to be a good value investor you need a f-you attitude to a degree. I understand that you need to temper the market volatility for some of your shareholders, but maybe that is telling a person that they have the wrong shareholder's?  If I remember correctly it is Munger who gets very upset when he is asked the question about how you would act different if it was just your own money you were investing versus running a public company or a partnership of sorts.

 

I think you need a f-you attitude in relation to the investment process..what you are buying and what you are selling.  I don't agree with that sentiment when it comes to empathizing with your partners.  It's their capital and they are your partners.  Buffett wrote to his partners as if they were all his aunt...in a simple to understand, straight forward manner.  He laid out the ground rules of how the funds would operate, but he never showed any sort of take-it-or-leave-it mentality.  I guess it comes down to personal choice.  I can say for a fact that it never hurt his results, and it certainly hasn't hurt ours in any manner. 

 

You could probably get away with that more in a public corporation than you can in a partnership.  We want our partners to be able to redeem their capital whenever they want...we don't lock it up, and we won't ever close the fund down so that they can't redeem. 

 

Having an f-you attitude to your partners is not a good plan your right, but you definitely have to be stern in your ways as they are paying you, to run the ship the best way you think possible… which could at times mean showing tough love to your partners.

Buffett is a good communicator which has helped him get to where he is. Barack Obama would never have gotten to be president if he was not good at conveying his messages, just like Prem would not have got to where he is if he was not a good communicator with his partners. I agree to talk to them like they are your ‘aunt’ but to make sure that they are not changing the way you are running money, to accommodate for them.

 

Buffett never showed any take-it-or-leave-it type mentality and I am not saying that a person should, but they have to run it the way they want too, and get shareholders that understand what they are trying to accomplish so they can help you accomplish these goals. Buffett did when he was younger kick people out of his partnership when they were causing him to run things differently than he wanted!! So I would argue to treat them as you would want to be treated if roles were reversed, but to steer the ship the way you want to and if they don’t like it, it’s not a good relationship for either of you.

 

Sanjeev, you would have a lot of knowledge with this, more than I would, and would have had to deal with a lot of difficult circumstances due to other's temperaments in the last while, so I am in no position to argue this point but know that any coach I have ever seen in hockey that coaches to keep other's happy, ends up sinking the ship... and he feels terrible about it, because he wasn't even doing what he actually wanted to do!

 

Bobby Knight has won three NCAA championships, but how many of you want to be Bobby Knight?  I certainly don't.

 

I think a coach's entire job is to find a way to motivate his team, and help them form a cohesive bond that allows them to reach their maximum potential, regardless of the circumstances.  I bet there are many different personalities within Fairfax's executive teams...just take a look at Sam Mitchell, Greg Taylor and Dennis Gibbs.  I think anyone who has met the three, would say that for the most part, they have very different personalities, even though they operate very successfully as a team. 

 

Now how do you manage the egos of three very different, very successful people, with three significantly different areas of expertise?  Well, a good coach takes more of the blame and less of the credit first of all.  Prem does that all the time.  In the years I've known him, I've never ever heard Prem take any credit for himself...ever!  It's always someone, or "we at Fairfax", or something to that effect.  Second, he knows how to make everyone feel useful...give them a very specific purpose and goal.  Why are the best penalty-killers in the league, guys that don't do a whole heck of alot other than that?  Third, you get everyone to buy in to the philosophy.

 

I agree I don’t want to be Bobby Knight either!!… I believe that people who run a business, family, sports team or whatever that way are doomed to not have success… surprisingly some do, but that style is not for me.

I agree with all the points you made above and that is one of the reasons they have so much success!

 

We mitigate risk to a certain degree for two reasons:  preservation of capital, and because regardless of how good the culture is at a company, you will always find investors that cannot handle the volatility as well.  It doesn't mean they aren't good long-term partners, but I think a 50% drop would scare off at least 30-40% of partners in a fund.  So unless you can meet redemptions for all those people, or lock up your fund, you are going to have to shut down. 

 

Take a look at Legg Mason.  You had a manager who was a God, and beat the markets for 16 years in a row.  One hit and he loses more than half his assets.  Miller runs a mutual fund, so he wouldn't have to close but what about all those hedge fund managers out there who did.  Even in Mohnish's case, he's fortunate that his redemptions are just once a year, and the bulk of the losses came in the last two quarters.  He didn't get much in redemptions.  But if his investors were allowed to redeem into the 1st Q of this year, it would have been a much different story.  His fund will recover alot of ground over the extra year he has now, and he'll end up keeping most of his partners, but if redemptions were allowed into the 1st quarter, he may have had a difficult time meeting redemptions.  In Seller's case, he closed his fund!  Cheers!     

 

If a person goes back and reads all Buffett’s letters from the start it is very hard not to notice how much he preps his shareholders for bad times, prepares them for events that have not yet happened, and teaches them about what he is doing. This helped him when he had the significant drops, as he had already talked about it happening and his shareholders expected it. You are right Sanjeev, that no matter how much you prepare your shareholders for when Mr.Market acts up, some will still be scared off.

 

“I feel this has a high probability of occurring one year in the next ten—no one knows which on” Warren Buffett- Talking about the market being down 35-40% in a year.

 

Marty Whitman tells the story of when he was buying Kmart’s debt and how he was talking to others in the investment business. They said that they knew it was a good deal, but they couldn’t buy them as there was to much ‘market risk’ and they could not stomach a 20-40% decline that could possibly happen. Whitman said that was hogwash and he didn’t care what happened to the price, because he felt that at the current price he was going to make a lot of money. The other investors missed out on a great opportunity because they were worried about the volatility for there shareholders….. which is why most underperform an index fund and become closet indexers.

I guess this is why the best in the world were looking for investor’s not shoppers when they started there investment funds.

 

“It is most important to me that you fully understand my reasoning in this regard and agree with me not only in your cerebral regions, but also down in the pit of your stomach”- Warren Buffett

 

I am in no way saying this about your fund or the way you invest Sanjeev, as I know full well that you don’t act that way. I know that your not scared to back up the truck when you see opportunity, even if it could potentially be tough for your partners in the short-term but thought it was relevant to the debate. Personally, I agree virtually everything you say and on a value investor’s bell curve I am pretty close to where you are in the ‘style box’ so it is quite out of character of me to be of a differing opinion even if it's a small one.

 

Debate on these answers would be great as it is a good learning experience to test your beliefs in front of others.. and maybe kill your best loved ideas! I know I don’t even know close to everything but these are my humble answers!

 

*Sorry for the length boardmembers... will make it shorter next time!

*Sanjeev, you are right on penalty killers too, there is definately specialization of labor in that game!

[JAllen]

Klarman said in a recent interview that they take a 10% position about every two years.  I think the current one (but has owned for a while) is Fox.

 

I think most of his positions are much smaller.

[ERICOPOLY]

It's not reckless but I wouldn't do it with a company that had  a 2% chance of blowing up.  That means over a 50 year investing career if you always have 50% of your net worth in one company than one year/morning you're going to wake up 50% more poor.  

 

 

A 2% chance of blowing up is a 98% chance of survival.  

 

The chance of that single company surviving 50 consecutive years is .98^50 = .364.

 

36.4% isn't great, but it's not quite as fatalistic as you made it sound.

[Mungerville]

Klarman also said in that interview that that 10% position would be in the debt or senior debt, not in the common as that would be too risky.